Barclays Capital has initiated coverage of Israel's oil and gas exploration sector, saying that its "risk is high, but so is the reward." According to Barclays analyst David Kaplan, "There is strong excitement surrounding the sector and concerning the opportunity for the Israeli companies and economy to become significant participants in the export gas market to Europe and the East." His stock pick is the most diversified company in the sector, Delek Energy Systems Ltd. (TASE: DEOL).
Barclays Capital gives "Equal weight" recommendations to Tamar and Leviathan partners Avner Oil and Gas LP (TASE: AVNR.L) and Delek Drilling LP (TASE: DEDR.L) with target prices of NIS 2.98 and NIS 14.55, respectively, and "Overweight" recommendations for their direct parent company Delek Energy, with a target price of NIS 1,805. It also gives an "Overweight" recommendation to Leviathan partner Ratio Oil Exploration (1992) LP (TASE:RATI.L), with a target price of NIS 0.80, but gives an "Underweight" recommendation to Tamar partner Isramco Ltd. (Nasdaq: ISRL; TASE: ISRA.L), with a target price of NIS 0.48
Barclays already covers Delek Group Ltd. (TASE: DLEKG), controlled by Yitzhak Tshuva. It reiterated its "Overweight" recommendation and raised its target price to NIS 1,242 from NIS 863. In Israel's energy sector, Barclays also covers geothermal energy equipment manufacturer and operator Ormat Industries Ltd. (TASE: ORMT), as well as Oil Refineries Ltd. (TASE:ORL).
Kaplan says local market has fully priced in the operational risks that lie ahead for the sector. He warns that the main risks to the industry are project financing and building infrastructure for export.
Delek Energy is Kaplan's stock pick because it already generates cash flow from Yam Tethys (the Noa and Mari-B licenses) and it is paid royalties (pre-tax) by Delek Drilling. It also has future potential cash flow from Tamar and its option on both the Leviathan prospect and future plans on projects in Cyprus in partnership with Noble Energy Inc. (NYSE: NBL). He says that CEO Gideon Tadmor is one of the top exploration and production professionals in Israel. Kaplan picks Delek Energy over parent Delek Group because Delek Energy is close to the exploration and production activities, while Delek Group has less upside.
Kaplan prefers both Avner Oil and Delek Drilling to Isramco and Ratio because they have a more diversified asset base, with holdings in Yam Tethys, Tamar, Dalit, Leviathan, and the Hanna and David licenses near Tamar. Isramco has only two holdings in two licenses - Tamar and Med Yavne.
Ratio has the most upside, but since it has only one holding - in Leviathan - the upside depends on the success of the prospect, it is a high risk/high reward share. Confirmation of the 16-trillion cubic foot gas reserve could be a catalyst for the share.
Kaplan warns that volatility will continue until the Sheshinski committee announces it final recommendations by the end of the year and the government passes legislation. The potential changes in the tax regime on gas sales, most importantly the cancellation of the depletion allowance, which will effectively raise royalties from 12.5% to 20%, and the levying of a special tax of 20-60% after the reserve has recouped 150% of its investment. He says that these changes could halve the value of Tamar's reserves from about $10 billion to $5.1 billion.
Kaplan notes that Tamar may receive an exemption from the taxes, because they might disrupt of the natural gas supply to Israel. Meanwhile, the uncertainty over taxes has put financing for the gas projects on hold.
Commenting on the development of Israel's gas exploration industry, Kaplan says, "Prior to January 2009 the only time Israel and E&P were mentioned in the same sentence was as a punch line to a joke." Yam Tethys came online in 2004, Tamar - eight times the size of Yam Tethys - changed the picture, and the potentially even larger Leviathan captured the imagination of the local markets. He cautions that Leviathan is still only a potential.
The key to industry is to increase demand for natural gas, and the Ministry of Natural Resources has published a plan on how to do this. Kaplan says, "We believe that growth in bubbling beneath the surface."
Delek Group's share price rose 2.7% by midday to NIS 1,278, Delek Energy's share price rose 3% to NIS 1,440, Delek Drilling's share price rose 0.9% to NIS 13.60, Avner's share price rose 1.2% to NIS 2.50, Isramco's share price rose 1.7% to NIS 0.432, and Ratio's share price rose 3.8% to NIS 0.518.
Published by Globes [online], Israel business news - www.globes-online.com - on December 16, 2010
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